Well-Control Coverage Drying Up for Small, Independents in Oil Patch

Oil and gas drillers in Texas are averaging about 40 new holes in the ground every day as the pace of looking for petroleum, especially natural gas, continues unabated in Texas and elsewhere, and that’s understandable. Industry forecasts estimate a 6.1 percent increase in the nationwide demand for natural gas by the year 2002. Many think that may be too conservative. The White House predicts a 50 percent increase in demand in the next two decades.

As of the end of July, the Texas Railroad Commission had issued greater than 21 percent more permits for oil and gas drilling compared to the same period a year ago-9,302 for the seven-month period ended July 31 in 2001, compared to 7,682 in 2000.

Reflecting the sector’s economic health, the drilling rig count worldwide was 2,345 operating in July, up 436 from a year ago, according to Baker Hughes Inc. In Texas during June the rig count stood at 508 compared to 329 the previous June. Nationwide July figures are 1,278 compared to 941 a year earlier.

Another factor contributing to the increased drilling activity is the strong pricing for petroleum, which is spurring investment in domestic oil fields. Oil companies are expected to increase spending on drilling and exploration by 20 percent to more than $100 billion this year, Salomon Smith Barney has reported.

Furthermore, Texas now has more producing gas wells than at any other time in its history-some 59,000 as of July. The railroad commission, which has oversight responsibility for the state’s petroleum sector, reports there were some 160,000 producing oil wells in mid-2001.

At the end of April there were 546 rigs operating in Texas, which is more than half the rigs operating in the entire U.S. Of those rigs in Texas, roughly 80 percent were natural gas rigs.

Industry observers and the railroad commission predict that the price of natural gas will rise and that will help boost exploration even more. And while this petro-patch boom has been good for the insurance sector, there may be some dark clouds just over the horizon, especially for the smaller independent drillers and operators.

“There is a problem developing in the market for the smaller operators especially drilling and workover contractors,” said Marcus D. Jensvold, president of M.D. Jensvold & Co. Inc., a Houston-based MGA. He said the market is drying up and that premium is skyrocketing chiefly for well-control coverage. He added, however, that there continue to be ample markets for general liability.

“Rates for the property side have gone from about $1.50 per thousand to as much as $5 per thousand in a few cases,” he said. “Especially for the smaller operators, 100 percent increases at renewal are not at all uncommon.”

He said that the market began a turn after Essex pulled out some six months ago. “They were writing about 50 percent of the business,” Jensvold estimated. “The only market left for the smaller guy now is a Firemans Fund facility.”

The traditional players for the larger risks remain—Liberty Mutual, AIG, Lexington, some of the London markets—but they have at least $25,000 minimums. “That rate is beyond the reach of most smaller outfits.”

Jensvold said that also contributing to the steep increases were a consolidation of the sector through mergers and acquisitions, buyouts; a consolidation of service and repair facilities; shortages of spare parts; the cost of new equipment and perhaps, most critically, the proliferation of inexperienced workers in the field.

Fort Worth retail agent Robert Carson, Higginbotham & Associates, agrees with Jensvold that the key force driving the rate increases may well be the number of inexperienced hands.

“Many if not most of the experienced hands fled the exploration sector in the past and that has often left operators today with less than optimal crews.” Carson said that one recruiter he knows has taken workers just as they’ve come out of prisons, because there is usually no problem in having them pass the drug tests. “It’s not common, but it has happened.”

“Underwriters, with a growing frequency, are requesting second opinions on drilling plans because of the problems encountered with the inexperience,” said Carson.

Carson also is finding that increases in well-control coverage are steep and “will probably get steeper.” He said that with loss ratios over the past four years in the 200 to 300 percent range, underwriters are trying to recoup. “Underwriters just let the premium get too low for too long,” he offered. “And rather than a gradual increase to recover, the rates are going up fast.”

Carson said he is experiencing some increases in general liability but only in the 20 to 25 percent range. “This is not really a problem area,” he said, agreeing with Jensvold.

The dramatic changes are happening in well control. “Lloyd’s is now the main market for this coverage and even there some of the former key syndicates have disappeared.” He said that no matter who really writes the coverage, Lloyd’s controls the market, if not directly, then through reinsurance.

This line may get a little worse for insureds before it gets better. “There may be less and less capacity between now and the end of the year,” Carson said, “based on the premium to surplus ratio.” The line is quickly coming close to the magic 3-1 ratio- $1 of surplus for every $3 in premium. “If carriers hit that ratio, the market will run out of capacity, and it will take awhile for the new premium to distribute to the surplus.”

The ratio may smooth out in 2002, but for now, Carson believes that underwriters can continue to be very particular. An estimated 90 percent of drilling and production operators today carry well-control coverage, but that has not always been the case. As recently as the 1970s only as few as 10 percent carried protection against physical damage. Carson placed his first well-control coverage in 1971.

Another factor driving rates for independents is the increase in litigation. With greater frequency insureds are taking carriers to court to settle claims. “Many carriers are simply taking a longer and harder look at claims,” said Carson. This practice often not only requires what many see as excessive time, but also does not honor the decisions of adjusters. “Even Lloyd’s is taking this approach.”

In an interview conducted earlier this year by Insurance Journal focusing on larger risks, Ron McElyea, president of Western Surplus Lines Agency Inc., Abilene, said that coverage for all drillers is uncommonly hard to find. “Underwriters are taking a hard look at the level of experience, age of the equipment, and the depth and breadth of the operation in putting together the policies for drillers,” he said.

Commenting on the pollution aspect of coverage, McElyea said that some of the forms are now more restrictive. “We are seeing endorsements required for risks to underground resources and more limited pollution cover,” he said. “Clean-up costs are now nearly always excluded,” he added.

Echoing McElyea, Anthony Koppel of Burnett & Company, said he has never seen a market driven to such a hard state by what he termed “excess losses.”

“It is very tough to place business right now and that has changed in only the last six months or so. There are more blowouts and bad holes. There are more losses associated with drilling,” Koppel said.

Gene Goodridge, worldwide energy manager of Chubb’s Dallas-based energy resources unit, reports also that premiums are up and will likely trend that way for now. “It is a severity issue,” he said, referring to the market today. Chubb, an admitted market, has raised prices some 20 percent, he said. Most admitted carriers, however, do not report the level of substantial restrictions as may be found in the surplus lines sectors.

Cover for oil spills
With control of well coverage and other forms addressing situations where oil goes out of control transitioning, the prospect of finding such coverage, is becoming more challenging. Nevertheless, it remains a necessary part of the total protection.

On average, the U.S. uses over 6 billion barrels of oil and petroleum products each year. (A barrel is equal to 42 US gallons.) To meet this demand, each year the U.S. produces an average of 3 billion barrels of crude oil and imports an average of 2.7 billion barrels of crude oil and other petroleum products.

With billions of barrels of oil transported and stored throughout the country, the potential for an oil spill is significant, and the effects of spilled oil can pose serious threats to the environment.

To address the potential environmental threat posed by petroleum, the U.S. Environmental Protection Agency has established a program designed to prevent oil spills. The program has reduced the number of spills from the total volume handled each year. The program is also designed to prepare for and respond to any oil spill affecting the inland waters of the United States. EPA’s oil program has a long history of responding to oil spills, including several major oil spills, and the lessons learned have helped to improve prevention and response capabilities.

Closer to home, some 675 barrels of oil spilled on land in Texas in 2000, according to the Texas Railroad Commission, which has jurisdiction over such spills in the state. Any spill in excess of five barrels must be reported to the RRC. (Offshore spills greater than 240 barrels or more than three leagues (about 10 miles) from a barrier island must be reported to the General Land Office.)

Pollution coverages for the oil and gas industry commonly address “sudden and accidental” pollution. While such coverage has not been uncommon in endorsement form, recent activity suggests that such endorsements are becoming more restrictive if they are available at all, according to McElyea.

“Today we’re finding that you have to buy pollution and control of well coverage separately,” said McElyea. “Most forms no longer include this coverage and Lloyds is about the only market left,” he added.

And premiums for clean-up coverage have gone up as much as 55 percent in some cases over the same coverage last year, McElyea commented.

Chubb offers its pollution coverage under a separate policy, “but steers away from the bigger threats such as blowout. Chubb has a special unit to handle the clean-up. We want to remove the health hazards as quickly as possible,” explained Goodridge.

“Pollution coverage often varies most among the host of specialty coverages,” according to Jensvold. “Included can be such items as time frame for discovering a loss; time frame for reporting; deductibles; whether coverage extends to clean-up costs, over-water operations, underground water pollution and saltwater disposal wells; and whether the form is for any-occurrence or named perils.

“Generally the owner-operator of the well is responsible for the damages resulting from uncontrolled oil; although, liability can shift under different contracts,” according to Jensvold.

Other coverage provisions can address issues such as cost overruns for remediation of a specific project which can arise from discovery of additional amounts of contamination, newly discovered contamination or changes in regulatory requirements. Typically not covered are bodily injury, property damage or other liability claims, legal defense costs and government negotiations. Often a self-insured buffer is included as a part of the estimate of clean-up costs. Coverage ends when cleanup is complete, unless further coverage is included for unknown pollution as a result of negotiating such a provision.

Experts caution that success will only follow a proper understanding of environmental coverage which requires the combination of a solid knowledge of the environment liabilities affecting the property or business as well as the law of environmental insurance. Two clear steps to successfully providing oil and gas pollution coverage are: 1. to correctly identify the potential sources of loss and the insurable interests in the transaction, and 2. to match or negotiate the available coverage with the anticipated loss exposure and the insurable interests.

Topics USA Texas Excess Surplus Energy Oil Gas Pollution Chubb